Amazon: Morgan Stanley Mulls Kindle ‘Ecosystem’ Prospects

By Tiernan Ray

Shares of Amazon.com (AMZN) are up *4.20, or 3%, at $266.80 today, a standout performer, rising at one point as high as $269.27.

The news programs have been pointing to the company’s announcement this morning of an expanded content agreement with CBS as a source of strength for the shares.

Amazon said it will feature “classic series” and “hit TV shows” from CBS and Showtime on its “Prime” instant video service, including “America’s Next Top Model” and “Everybody Loves Raymond.”

But Street analysts today were more interested in broad e-commerce trends and the business model for Amazon.

Piper Jaffray’s Gene Munster, who has an Overweight rating on Amazon shares and a $329 price target, writes today that data from market research firm ChannelAdvisor suggest that January sales saw 34% year-over-year growth, up from 30% in December, though it was lower than the 39% average for all of Q4. Given that ChannelAdvisor’s data “have led Amazon sales by only 12 percentage points,” the actual sales results for the current quarter are probably trending “in line” with his estimate for $16.15 billion and a penny per share, he thinks. That is slightly the Street consensus for $16.17 billion and 8 cents a share.

Topeka Capital Markets’s Victor Anthony, who has a Buy rating on the stock, looking at the same data, sees mild upside, writing that ChannelAdvisor’s data “implies North American growth would be 27.4%, an acceleration from the 23.0% reported in 4Q12, and slightly ahead of the 26.2% estimated in our model for 1Q13.”

Morgan Stanley’s Scott Devitt, who has an Overweight rating on Amazon, writes that without the content sales that come from Amazon’s Kindle e-book readers, its operating profit results would be even worse.

What he calls the Kindle “franchise,” which includes not just the hardware unit sales but also content sold to Kindle owners, produces 11% of Amazon’s sales and 34% of its consolidated segment operating income, according to his estimates.

Now, Devitt thinks Amazon’s enjoying much higher sales on e-books than he’d previously believed, based on commissioned survey results by his firm:

In our April 4, 2012 note on Amazon.com titled Longer Ramp to Margin Expansion Due to Variable Cost Structure, we estimated worldwide eBook unit sales of 567MM in 2012 based on a tie ratio of nine eBook purchases per eReader and three eBook purchases per tablet. Having recently conducted an AlphaWise survey on 1,108 owners of eReaders and tablets in the US, we believe the eBook market is actually much larger and will grow faster than we initially assumed. According to our AlphaWise survey of US consumers, eReader owners purchase on average ~2 eBooks per month and tablet owners purchase ~1 eBook per month. Given eBook tie ratios are probably lower outside the US and to factor in a discount in annualizing tie ratios, we take a 40% haircut to our AlphaWise survey tie ratios to arrive at ~13.3 eBook purchases per eReader and ~6.4 eBook purchases per tablet in 2012. Taking our new tie ratios and our updated forecasts on the installed base of eReaders and tablets, we estimate worldwide eBook unit sales of 859MM in 2012 (~50% higher than our initial forecast of 567MM). On the following page, we illustrate the changes in our estimates on the worldwide eBook market.

Devitt thinks Amazon may capture some market share in e-book sales, after losing share to Apple (AAPL) for quite some time.

Apple changed the e-book pricing model for the industry to the “agency” model, allowing for relatively higher prices. Amazon, in contrast, is willing to allow for much lower prices than the agency model.

Apple moved the eBook industry towards an agency model and turned off in-app purchasing for Kindle iOS apps, which we believed contributed to Amazon.com’s eBook market share declining from 60% in 2010 to 45% in 2012. However, five of the largest publishers (Penguin, Simon & Schuster, Hachette, Macmillan and Harper Collins) have settled with the Department of Justice over the past six months and terminated their agency agreements with Apple (Random House was not included in the litigation). While the initial settlement appears to last only two years and could include certain clauses that limit discounting (such as eBook retailers cannot cumulatively sell eBooks of a publisher at a loss over the period of a contract), we believe the movement back to a principal pricing model will greatly favor Amazon.com.

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There are 3 comments

FEBRUARY 13, 2013 3:31 P.M.

Other People's Money wrote:

If people knew that their 401ks, pensions and mutual funds were filled with these outrageously valued bubble stocks, I wonder how much Gene Munster and The Pipers of the world would be able to inflate their value with puffery. Face it, amazon would be a $50 stock ,at best, if people were investing their own money instead of a fund manager tossing the cash around with reckless abandon.

FEBRUARY 13, 2013 9:23 P.M.

Anonymous wrote:

Amazon is humungous. And the Kindle accounts for 11% of Amazon's revenue and 34% of their profit. How much weaker can you be before people wake up. The Kindle is a POS. BTW. A real POS. 34% profit for Amazon. What a dickless wonder.

FEBRUARY 14, 2013 10:01 A.M.

P&L wrote:

How can he cut his revenue estimate for 2013 from $81.1B to $75B; 2014 from $105.7B to $91B and still be bullish this stock? He made these cuys inside of a month!

About Tech Trader Daily

Tech Trader Daily is a blog on technology investing written by Barron’s veteran Tiernan Ray. The blog provides news, analysis and original reporting on events important to investors in software, hardware, the Internet, telecommunications and related fields. Comments and tips can be sent to: techtraderdaily@barrons.com.